There's a debate raging up on Wall Street these days. One side insists that the S&P 500 is already poised for the next bull market, just 5% from a fresh all-time high, while others insist that the recovery will hit a speed bump and could ultimately be derailed as economic headwinds linger.
Whichever turns out to be true, most agree that the advent of artificial intelligence (AI) has had a profound effect on the technological landscape. Companies large and small are scrambling to profit from recent advances, which have the potential to deliver marked improvements in productivity.
There's rarely consensus on Wall Street about anything, but most market watchers agree that one company is in the best position to reap the rewards of the rapid adoption of AI: Nvidia (NVDA 6.18%). Even though the stock has already gained roughly 220% so far in 2023, there's plenty of reason to believe Nvidia has a long and lucrative road ahead.
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AI and more
It's important to take a step back to see that while AI is Nvidia's latest opportunity, it's far from the only one. The company initially developed the graphics processing unit (GPU) to solve the problem of boxy images in video games and soon rose to dominate the field.
However, Nvidia soon discovered that parallel processing -- running a multitude of complicated mathematical calculations simultaneously -- could also be applied to other emerging technologies. The company quickly pivoted to combine hardware and software stacks for other computationally demanding applications, including data centers, cloud computing, high-performance computing, and -- of course -- AI. This ability to adapt to new use cases is evident in Nvidia's stock performance, which has soared 11,380% over the past decade.
You need only review Nvidia's recent results to understand the magnitude of the current opportunity. For Nvidia's fiscal 2024 third quarter (ended Oct. 29), the company delivered record revenue that jumped 206% to $18.1 billion, while its diluted earnings per share surged 1,274% to $3.71. While the magnitude of the increases is partially the result of comparisons during last year's market slump, it helps illustrate how adept Nvidia is at addressing the opportunity at hand.
The biggest contributor to the results was Nvidia's data center segment -- which includes processors used for artificial intelligence, cloud computing, and data centers -- which generated record revenue that soared 279% to $14.5 billion.
Management expects Nvidia's growth spurt to continue. For the upcoming fiscal fourth quarter, management is guiding for record revenue of $20 billion at the midpoint of its guidance, which would represent a surge of 230% year over year. Nvidia was clear that the strong and accelerating demand for AI was driving the company's robust growth.
No one knows for sure how big the market for AI will ultimately be, but even the most conservative estimates are staggering. Generative AI alone could grow at a compound annual growth rate (CAGR) of 42%, reaching $1.3 trillion by 2032, according to data compiled by Bloomberg Intelligence.
By providing the technology that underpins AI, Nvidia has backstopped its future.
The future looks bright for Nvidia
While AI is certainly the current driver of Nvidia's growth, there are certainly others.
Even in the face of rising competition, Nvidia remains the undisputed leader in the discrete desktop GPU market, with a dominant 80% share, according to data compiled by Jon Peddie Research (courtesy of Tom's Hardware).
By all accounts, growth in the gaming market for GPUs is expected to continue, rising from $2.7 billion in 2023 to $11.7 billion by 2028, a CAGR of 34%, according to market research provider Mordor Intelligence. A recovery from last year's slump will no doubt give Nvidia a boost.
Another trend fueling Nvidia's growth is the digital transformation, as more companies shift workloads to the cloud, which requires additional investment in data centers. Nvidia controls 95% of the data center market, according to CFRA Research analyst Angelo Zino. The market opportunity is expected to climb from $263 billion in 2022 to $603 billion by 2030, a CAGR of 11%, according to Prescient and Strategic Intelligence Market Research. This suggests that Nvidia is well positioned to prosper from this secular tailwind.
Circling back to AI, Nvidia was already the clear leader in solutions for machine learning -- the area of AI that deals with self-learning algorithms. Nvidia controls an estimated 95% of the market, according to data provided by New Street Research.
This combination of opportunities and market dominance shows that Nvidia has a long and potentially prosperous road ahead.
The fine print
I'd be remiss if I didn't address the 800-pound gorilla in the room. The spike in Nvidia's stock price this year has caused a commensurate increase in its valuation. The stock is currently selling for 45 times forward earnings and 6 times next year's sales. While those metrics might at first seem outrageous, they must be viewed in context.
Nvidia has reported two successive quarters of record-breaking triple-digit revenue and earnings growth and expects to deliver a third. A performance of this magnitude is certainly deserving of a premium valuation, but in the end, investors will have to decide what multiple they're comfortable with. The stock has already pulled back 10% from its recent high (as of this writing), giving astute investors a cheaper entry point.
Demand for AI will likely continue from here. When added to Nvidia's other opportunities in the gaming and data center markets, I'd argue the stock is worth the premium -- but it simply won't be for everyone.
